Twenty years of false starts have trained fund managers to resist the December urge to predict that the coming year would see Japan’s resurgence. The past 10 years’ equivalent to that has been learning, the hard way, not to trumpet the year of Microsoft (MSFT).
For a decade-plus, the erstwhile largest market capitalization in history—a juggernaut worthy of modern-day trust-busting—has gone to nowhere and back. Even as Microsoft’s fiscal-year revenue has nearly tripled to $74 billion since 2002, its shares have lagged the Standard & Poor’s 500-stock index by more than 60 percentage points. Never mind how Redmond, Wash., has dutifully plowed tens of billions into research and development and returned gross national product sums of dollars to its shareholders. You cannot help but fixate on how the world’s biggest software company whiffed, several times, on the mega-shift to mobile and tablet computing.
The overwhelming temptation may be to cheer up and become a Microsoft contrarian. At 27, the shares trade right at their 10-year average and yield more than it costs the company to issue debt. Redmond has Skunk-Worked a somewhat exciting new tablet and operating system that it’s raring to showcase at tens of new stores across the country. It’s all backed by still-obnoxious amounts of free cash flow and a fortress-like balance sheet. Would that you could turn a leveraged buyout on such a fat Holstein.
Don’t buy it, says Barry Ritholtz, an asset manager who runs FusionIQ, a quantitative research firm, and who founded the blog, the Big Picture. Over several interviews by telephone and e-mail, Ritholtz has expanded on thoughts he is fashioning into a future post about Microsoft. He considers the company a “classic value trap,” not unlike what its customers Dell (DELL) and Hewlett Packard (HPQ) were at the start of this annus horribilis. Microsoft Chief Executive Officer Steve Ballmer, he says, “is the worst CEO in technology, and as long as he is running the show—he has missed every major trend in tech over the past decade—I have no confidence in the company. Avoid it.”
Funny: Activist investor David Einhorn has wanted Ballmer out for more than a year and was long the shares in hopes that such an ouster would boost Microsoft’s returns. The stock is up 3 percent this year, compared with the S&P 500’s 14 percent gain. The 13 years since Ballmer became CEO have included the Vista debacle, a thankfully thwarted bid to overpay for Yahoo! (YHOO), the ceding of search supremacy to Google (GOOG), and Apple’s (AAPL) envisioning and dominating much of the smartphone and tablet markets. Meanwhile, where’s that “Skype Phone” in every palm?
“Ballmer is a college buddy of Bill Gates, and I suspect that counts for a lot,” says Ritholtz, who holds no position in the company. “Ask yourself this: If an arms-length CEO (not a ‘friend of Bill’) had been overseeing Microsoft the past decade, would he still be there? Has Ballmer taken a ‘find my successor’ approach to his next tier of execs? Or has he surrounded himself with a fiercely loyal, yes-men crew?”
Bill Koefoed, Microsoft’s general manager of investor relations says, “‘Value trap’ is always a funny term.” Microsoft, he says, is trading in line with the big-cap technology sector, which has recently been out of favor with investors.
“Enterprise tech hasn’t been as sexy to the press. But our relevance to the enterprise has grown in a huge way. Our database business is growing faster than Oracle’s (ORCL) and IBM’s (IBM).”
Koefoed says people focus on Windows, which provides a quarter of Microsoft’s overall revenue, but not on the comparable 25 percent contribution from the company’s servers and tools division, which he emphasizes that Ballmer has grown, from a $3 billion business, to a $19 billion enterprise over the past decade.
“The market goes in cycles,” he says. “Over time, the stock price works itself out. We’re doing a whole bunch of things to be shareholder-friendly. Over time, that will be reflected in our share price.”
Meanwhile, Koefoed says, it was under Ballmer that the company initiated and consistently increased its dividend—with Microsoft shareholders overwhelmingly backing the CEO last month.
Still, says Ritholtz, “Think of the difference between what is revealed by a single snapshot of Microsoft today vs. an extended video. Yes, you can see the current situation of lots of cash, a low price-earnings multiple, name recognition, enterprise usage. But what about the trajectory and changes to the underlying market for their goods and services?”
He says that other than Kinnect for Xbox 360, “it’s hard to see what Microsoft gets for its billions of [research and development] dollars.”
“The competitive landscape has been moving against Microsoft,” wrote N. Landell-Mills of Indigo Equity Research after Microsoft’s “uninspiring” latest quarterly report, which involved the company raising its dividend 15 percent. The analyst called the organization “un-innovative and complex” and “a digital dinosaur.”
The full rollout of Windows 8 could, of course, change that state of affairs. Not that early signs are promising.
With the PC replacement cycle stretched out and assailed by competition that Microsoft failed to oppose, Ritholtz has taken to comparing its fate to that of Maytag (WHR). “It was,” he says, “once hugely successful and innovative and created lots of products and markets. Now you replace your dishwasher every 10 years; that’s the only time you even think of Maytag.”
